The CFPB and Behavioral Economics

posted by Adam Levitin

This post is an extended aside from my previous post about David Evans' argument about the CFPB's mindset and institutional incentives. The point isn't critical to Evans' argument, but I'm writing because it really irks me because it shows such a lack of understanding about the CFPB. Specifically, Evans suggests that the CFPB's supposed emphasis on preventing consumer harms rather than maximizing consumer welfare stems from the CFPB’s “intellectual foundation in behavioral economics.” This just wrong. The CFPB really doesn’t have a behavioral economics DNA. (Heck, behavioral economics hasn't made much of a mark on government in general).

Elizabeth Warren, the intellectual godmother of the CFPB, was not a behavioralist. Her basic argument for the CFPB was that an administrative law one—having a dedicated agency for consumer financial protection was likely to be more effective than in the mission were scattered across a dozen agencies, most with other, more pressing missions. Nothing behavioralist there, and not an iota of it to be found in her original article proposing a CFPB. (Her co-authorship with Oren Bar-Gill of an expanded version of the article didn’t make it a behavioralist idea.) Likewise, during the legislative process all of the obviously behavioralist stuff, like the “plain vanilla” requirement, didn’t make it into the final legislation. Indeed, I can’t point to anything in any CFPB rulemaking or enforcement action that is clearly behavioralist. At best one can point to Sendil Mullainathan having been the head of the CFPB's research team for a while, but that doesn't make the agency inherently behavioralist.

Contrary to Evans’ claim, the CFPB is not predicated on the idea that consumers routinely make bad choices. It is predicated on the idea that a subset of businesses actively seek to take advantage of consumers through sharp practices for the very simple reason that those practices are profitable. This is a totally market-driven view of the world. Why take advantage of consumers? Because it pays. Change that calculus and behavior changes. The CFPB is based on the idea that when consumers are presented with clear, accurate information they will make the choices they want. The fundamental economics tautology of revealed preferences is not in question. Instead, the CFPB is emphasizing an obvious corollary to revealed preferences: that they reflect the information available to the consumer. When there is warped information, consumer decision making is warped. Consumer behavior reflects true consumer preferences only when there is full and accurate information. Thus, when businesses deliberately obfuscate pricing through their form or context of disclosures or through product design, consumer decision-making will be warped. Correcting informational problems in markets is not the same as addressing cognitive biases. It's a pretty standard market efficiency move, not a behavioralist move.

Likewise, the CFPB picked up a whole bunch of pre-existing federal statutes, none of which have anything remotely behavioralist in them. Instead, if there’s anything behavioral it would be in the CFPB’s unique power: the ability to prohibit unfair, deceptive, and abusive acts and practices (UDAAP). UDAAP is aimed at rooting out sharp practices—actions that are unfair, in that they are more likely to harm than benefit consumers, that are deceptive, or that are abusive, in that they take unreasonable advantage of consumers. Unfair and deceptive are hardly controversial—the FTC and bank regulators have had those powers for decades. “Abusive" has been more controversial, but mainly because of its supposed novelty. It’s meant to be a standard-like equitable gap filler, but the basic idea shouldn’t at controversial. Indeed, the FTC's interpretation of "unfair" from the 1960s until 1980, which was upheld by the Supreme Court, looked a lot like "abusive". Reasonable minds might disagree about the application, but that isn't itself a problem. In any event, the idea of prohibiting unfair advantage comes out of contract law, with doctrines like unilateral mistake (when the other party knows of the mistake) or duress. So I’m just not seeing (1) what’s behavioralist about the CFPB and (2) why that translates to a supposed focus solely on consumer harm, not consumer welfare (which as I discuss in the previous post is an inaccurate view that fails to account for all of the work the CFPB does beyond rulemaking and enforcement).

Comments

Amen, brother. "Behavioral economics" seems to be dinkum science, but hasn't done much for social engineering . AFAIK, the only "behavioral economics" that has made it into anybody's regulations is the default contribution to 401(k)s. This is a good thing, but any marketer could have recommended this 40 years ago.

I enjoyed reading your blog post and found your information about behavioral economics to be very helpful. I also agree with the statement here that consumers are taken advantage of because it pays. Thank you for sharing your knowledge.

This claim is puzzling to me Adam. I always think of the Warren/Bar-Gill article as at least a large part of the academic background for the CFPB, and it is clearly grounded in behavioral economics. And, the CFPB does use behavioral economics to justify rulemaking. In 30 seconds of trying to come up with an example, I found this instance in the CFPB payday lending rule: "This concern is exacerbated
by the available empirical evidence
regarding consumer understanding of
such loans, which strongly indicates
that borrowers who take out long
sequences of payday loans and vehicle
title loans do not anticipate those long
sequences." https://www.gpo.gov/fdsys/pkg/FR-2016-07-22/pdf/2016-13490.pdf at p.47927. Obviously one example doesn't mean anything, but Warren and Bar-Gill make this same argument in their piece, showing a link between the intellectual background and the actual work of the Bureau.

The first point I'd make is that the CFPB does not have an academic background. Warren's original proposal was in a quasi-popular policy journal. Legislative efforts were already well afoot for what was at the time conceived of as a "Consumer Financial Product Safety Commission" (see the original Durbin bill) before the Warren/Bar-Gill piece appeared. Bar-Gill added a behavioral patina to Warren's original piece in the joint article insofar as the article explains some of the problems faced by consumers, but the proposed solution--the consolidation of consumer financial protection in a single agency--doesn't have the slightest behavioral tinge. Put another way, remove all the behavioralist points from the Warren-Bar-Gill article and you still get the same policy proposal. The behavioralist stuff is dictum.

I don't claim that the CFPB ignores behavioral economics. It's part of the CFPB's toolkit. But it isn't what drives the CFPB. As far as the payday example, three points.

First, consumer mis-anticipation of rollover sequences is consistent with, but not necessarily a behavioral economics observation. But I'm happy to concede a behavioralist reading here.

Second, the behavioralist response would be to try and debias the consumers (the nudge) by changing the form in which consumers receive information or the choice architecture. The CFPB's response has been to restrict rollovers (the traditional sharp elbow--or perhaps The People's Elbow).

Third, the problem with payday loans isn't dependent upon a cognitive bias or on consumer understand whatsoever. It's that the loans are not underwritten to an ability-to-repay in full and that consumers are relying on what is structured and priced as a short-term credit product for longer-term credit needs. Thus, the rule is drafted as an ability-to-repay requirement, not a requirement that consumers understand the likelihood that they will end up in long rollover sequences.

Here's my ultimate test: would the CFPB or its rule makings look any different if behavioral economics did not exist? The answer is no. I can't point to any material point where behavioral economics has shaped the CFPB or its policies, even if one can find the occasional reference to it.

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